Change, competition and consolidation in asset management

Over the past few years, every part of the finance world has been affected by macroeconomic turmoil and has faced significant changes to the way in which it works. Asset management is no exception, so here we ask an expert commentator - Investment Director at Fidelity Worldwide Investment, Tom Stevenson - to give us a run-down of what those in the asset management industry are thinking about right now, and where the future might take this sector.

Impact of the financial crisis

There's been no shortage of analysis of how investment banks have changed in the wake of the financial crisis and subsequent economic downturn, but less on the effect of these events on the industry. So our first question for Tom is: how have Fidelity and other asset management firms weathered the events of the past few years? Tom points to a solid increase in assets under management since December 2008 - as much as 30 per cent, according to the latest figures from the Investment Management Association. As the fees that asset management firms charge are generally a percentage of the funds they manage, such an increase bodes well for profits. Says Tom, "In headline terms, you could say that the asset management business has fared quite well since the financial crisis."

Tom explains that this increase in funds under management is partly due to patches of economic recovery since 2008, but also to the fact that investors are finding the products that asset management firms offer more and more attractive: "Interest rates have been pulled down to practically zero on both sides of the Atlantic, so investors are finding it increasingly difficult to find the income that they need from cash deposits. They are therefore moving towards our funds. This trend is likely to continue because it looks like interest rates are going to stay very low for quite a long time."

There was much talk in the years before the financial crisis of asset management firms adopting some of the methods of their more adventurous cousins, hedge funds. Hedge funds are known for their use of complex, and sometimes risky, financial products and techniques to attempt to ensure a good return under any economic circumstances. But, as Tom points out, "one of the consequences of the financial crisis is that investors are a bit more sceptical about the attractions of more complicated investment techniques", so are "looking for greater simplicity and transparency in their investment funds" - while still wanting the same high returns, of course. He continues: "We're finding that people are gravitating towards vehicles like our multi-asset funds, which might invest in shares, bonds, property, and commodities." He explains that these funds are achieving the same strong results under a variety of market conditions as hedge funds, but "in a simpler and more transparent way."

Pensions reform

The sums of money that asset management firms deal with in the future looks set to increase for other reasons too. Pension schemes are a huge part of the asset management business and, thanks to government reform of this sector, the number of people involved in them is going to increase significantly. Tom tells us more: "One of the key changes that's coming up is the introduction of what's called auto-enrolment, which basically means that people will be assumed to join a company pension scheme unless they choose to opt out." This step is generally very good news for the asset management industry as more funds managed means more fees, but, as Tom cautions, "it also means that the amount of money we need to spend on technology and the other costs of running these schemes will be higher."

The other significant transition in the pensions industry which Tom highlights as significant for asset management firms is "a long term and unstoppable shift from what are called defined benefit pensions (where a retiree gets a percentage of their final salary yearly) to defined contribution pensions (where a retiree gets a lump sum based on the money they've put in)." Tom sees this shift as a crucial one for the asset management industry to appreciate: "Firms that are doing well are the ones that have strong defined contribution businesses. The ones which have been reliant on defined benefit pensions have struggled in the past few years."

Exchange-traded funds

An exchange-traded fund is a fund which investors can buy into directly through the financial markets, cutting out the role played by an asset management firm. These funds are generally set up to invest automatically in all the firms currently in a particular stock market index, such as the FTSE 100, rather than in investments chosen by a fund manager. They've become increasingly popular in the past few years, and Tom gives us his take on why: "Firstly they're perceived to be simple products, and secondly, they've tended to be cheaper than actively managed funds because less research is involved in the process of running them."

Tom believes that such funds will continue to compete with conventional funds in the future: "If fund managers are going to charge higher fees than ETFs to reflect the research and analysis they do, they need to justify those fees with better performance. And to the extent that they don't produce that performance, ETFs will continue to be a popular alternative." Tom, however, goes on to note that some actively managed funds have consistently outperformed ETFs over the past few years.

Tom goes on to highlight the dangers that some ETFs could pose to investors. Synthetic ETFs, which do not hold the assets on which the fund is based but instead use derivatives to mimic the returns these assets produce, are seen as particularly risky. While the derivatives used operate correctly, all is well, but, as Tom points out, "if the investment bank servicing that derivative were to go under, investors' money would be at risk." He concludes: "I think that the idea that ETFs are simple and transparent has been shown to be not quite the case - there are dangers there."

Globalisation

Tom next highlights how the asset management business has become increasingly global over the past few years: "Investors are less interested in investing in their local market and more interested in either investing in emerging markets, or on a global basis, that is, accessing the best investments, whatever country they're found in." Tom picks out Asia as a market with particularly strong growth prospects, and therefore particularly attractive at the moment to investors.

What impact will this shift to a global perspective have on asset management firms? Says Tom: "I think that larger investment houses like Fidelity with research teams and portfolio managers all around the world will benefit. They can provide a global breadth of coverage which small boutique firms are unable to do."

Industry consolidation

The number of asset management firms has fallen in recent years. Tom gives us some interesting statistics: "By the end of 2010, there were 101 fund companies in the UK, down from a total of 118 five years earlier. In the last two years alone, the number of asset management firms has fallen by around 15 per cent, according to the Investment Management Association."

Tom explains that this consolidation is not due to a lack of success in the sector, but reflects the fact that asset management is an extremely performance-focused area of the finance world, where business is dominated by the best: "The top 100 funds in the UK control about 45 per cent of assets under management, and the top 10 about 11 per cent. It's a competitive industry - if you're not number one or two in your particular sector, you're probably not attracting any new assets at all." So asset management firms not performing well for their clients are likely to fail, or be taken over by competitors, meaning that those, like Fidelity, which remain and prosper are of a very high calibre.

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